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Global FX
The euro area’s debt crisis remained on the radar screen of currency investors, but the US Federal Reserve’s latest decision to maintain an ultra-loose monetary policy for longer also influenced trading.
The dollar came under some selling pressure after the Fed pledged after its latest policy meeting to keep short-term interest rates near zero at least through late 2014. Fed Chairman also left the door open for further monetary easing, that is, QE3, should economic conditions deteriorate. Such expectations led to a rally in riskier assets, benefitting the euro and the commodity-linked currencies. The euro rose to a 6-1/2 week high of 1.3235 against the greenback on January 27, and the Australian dollar jumped to a six-month high of close to 1.08 on February 3.
However, investors remained concerned about the situation in Greece, as the country continued to hold talks with private investors to restructure its debt. A deal is critical if Greece is to secure its next round of bailout funds before a bond repayment comes due in March. Otherwise, the country might have to default. There was also fear that the situation in Greece would trickle out to Portugal, Spain or Italy, which are not only much larger in size, but have bigger debt outstanding.
Looking ahead, while Europe’s debt crisis will remain the market’s main focus, central bank actions might be another factor influencing moves in the foreign exchange market. With the yen and Swiss franc gaining ground against the dollar and euro respectively, it is possible that both the Bank of Japan and the Swiss National Bank could intervene to curb the strength of their currencies.
Interest Rates
The US Federal Reserve vowed to maintain a highly accommodative monetary policy stance for a longer period to support a stronger US recovery. In a statement released after its two-day meeting on January 24 to 25, the US central bank said that US economic growth would remain modest and the unemployment rate would decline only gradually. The Fed also sees strains in global financial markets to pose significant downside risks to the economic outlook.
In their latest projections, US policymakers revised down their US GDP growth forecast for 2012 to a range of 2.2% to 2.7%, from 2.5% to 2.9%, while changing their forecast for the unemployment rate to 8.2% to 8.5%, from 8.5% to 8.7%.
In an attempt to further stimulate growth, policymakers decided to keep short term interest rates near zero at least until late 2014, longer than previously indicated. They would also maintain existing policies of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities (MBS) in agency MBS, and of rolling over maturing Treasury securities at auction, as well as keeping the programme to extend the average maturity of its holdings of securities as announced in September, i.e., the so-called Operation Twist. Moreover, Fed Chairman Ben Bernanke said in the post meeting news conference that more monetary stimulus is possible if economic conditions deteriorate. Many expect this to be in the form of purchases of mortgage-related debt securities as it may help jump start a recovery in the still weak housing market.
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